Shining a light on the path to sustainability

Andrew Epsom speaking at Insurance Climate Disclosures

Achieving sustainability targets must consider both business and environmental demands and opportunities. Andrew Epsom, insurance client solutions director at Royal London Asset Management discusses the merits of balancing both quantitative metrics and qualitative assessments in addressing climate challenges disclosures.

We are seeing changes in the way our society looks at the impact of governments, companies and individuals on our society and environment. We know companies are increasingly looking at their impact given our own actions and the companies that we engage with. Changing regulation and greater scrutiny from customers is accelerating this trend, meaning that financial companies are looking at the impact of their investments more closely than ever.

In our experience, most insurers are not looking for an immediate full-scale decarbonisation of their investment portfolios, preferring to facilitate a longer-term transition to a lower carbon and more sustainable economy for most of their assets, in the belief this will deliver better environmental and financial outcomes.

Given the infancy of climate risk monitoring and management, there are a number of obstacles which the finance industry is navigating:

Many carbon metrics are backward looking and therefore portfolios can often show high emissions, even when they have material exposure to issuers with credible transition plans.
There is a drive to measure and quantitatively monitor the credibility of company transition plans, however, forward-looking metrics such as Implied Temperature Rise (ITR) are still in their infancy in their methodology, and the data is also far from complete.
Most insurers are looking to have a more holistic and inclusive approach to emissions reductions (e.g. issuers should be prioritising a “Just Transition” as part of their transition plans) and hence there is the need to also disclose how this is being achieved.
Allowing for all of the above, the potential disclosures that insurers need to make to justify their approach may theoretically need to be detailed and lengthy, but this needs to be balanced against the fact these are meant to be consumed publicly and hence there needs to be simplicity and clarity in the disclosures.

What are the possible solutions?

Implementing this in practice therefore presents various challenges around data, methodology, and how to disclose this in a coherent manner regarding sufficient detail to rationalise – in particular if there presents a high level of initial emissions – but in a format that can be relatively easily understood by external parties.

We typically see the definition of four key stages for insurers utilising a sustainability solution that involves a longer-term transition:

1: Set Objectives – sustainability criteria including exclusions policy, financial objectives, risk limits & SCR (Solvency capital requirement) constraints.

2: Initial filtering of universe – valuation considerations, alignment with sustainability criteria (including but not exclusively climate-related risks), alignment with other criteria (financial objectives, risk limits, SCR), qualitative and quantitative approaches used for both alignment assessments & overall portfolio diversification.

3: Ongoing assessment – regular updating of the considerations for the initial filtering of universe, in particular, to ensure that the overall thesis for investment remains appropriate (e.g. is the decarbonisation trajectory in line with expectations?), updating of quantitative and qualitative measures.

4: Ongoing engagement – confirm expectations, issue questionnaires. dialogue with senior management, sector thematic reviews.

Appropriate implementation, risk management and disclosure frameworks need to be developed consistent with the above, but again this presents challenges across certain areas.

Balancing quantitative vs qualitative

Using quantitative metrics to measure and monitor exposure to climate risk can be useful in helping us to better understand the current position of our portfolios, as well as trajectory in relation to becoming Paris Aligned.

On a forward-looking basis, insurers are often using the Implied Temperature Rise (ITR) metric. ITR aims to measure the warming the emissions from a company would drive by the year 2100, if the whole economy had the same over- or under-shoot level of greenhouse gas emissions. It is based on the company’s most recent Scope 1, 2 and 3 emissions, projecting these to the future and incorporating the companies’ targets. The metric is expressed in degrees Celsius.

Quantitative assessments are useful outputs to understand current position and trajectory, but often represent a simplification of a highly complex issue, and often have issues around methodology and data coverage. It is therefore critical to use these as a complement to more qualitative assessments.

Through qualitative assessments, more detailed reviews of the credibility of issuers climate transition plans can be assessed and this information can be used to better inform investment decision making. As part of our own commitment to deliver net zero by 2050 (see pull-out box), and our interim target to achieve a 50% reduction in our financed emissions by 2030 against a 2020 baseline, we have set out a programme to engage with companies who represent the largest proportion of financed emissions in our portfolios. As part of this, we will assess issuers climate transition plans against 12 milestones we have set to assess the credibility of such plans. We aim to engage every year and encourage issuers to improve the credibility of their transition plans.

Our net zero commitment
At the heart of our approach is our commitment to achieving net zero by 2050[1] and reducing our carbon equivalent emissions by 50% by 2030 for our in-scope assets, using 2020 as the baseline year. Our in-scope assets are those in funds managed and controlled by RLAM, excluding segregated mandates managed on behalf of external clients. Our commitment is based on the expectation that governments and policy makers will deliver on their commitments to achieve the 1.5˚C temperature goal of the Paris Agreement and that this action does not contravene our fiduciary duty to our external investors. We are actively working to support our external clients with assets in segregated mandates where they have made an explicit commitment to achieving net zero, as disclosed to the Net Zero Asset Managers Initiative (NZAMI).

Our objective is to evaluate and/or influence through engagement with issuers representing 70% of our corporate financed emissions, pushing for adoption of emissions reduction targets linked to science-based sector specific alignment methodologies (such as SBTi, the Science-Based Targets initiative) and climate transition plans. We also expect client engagement alongside methodology development in particular asset classes and any development of climate solutions should increase the proportion of AUM in line with net zero over time. We will review the progress of our implementation and commitments on an annual basis as part of our continued Climate Report disclosures.

The 12 milestones are shown below:

SET EMISSIONS REDUCTIONS TARGETS ALIGNED WITH 1.5ºC AMBITION

1. Reach net zero emissions in a timeframe aligned with 1.5ºC ambition
2. Include emissions from scope 1, 2 and material scope 3 activities in targets
3. Only offset residual emissions following net zero aligned offsetting principles

BRING OTHERS TO NET ZERO

4. Commit to scaling-up technology and solutions required to achieve net zero
5. Lobby for a policy that accelerates the transition
6. Engage with the complete business value-chain, communities, and workers to ensure a Just Transition
7. Invest in adaptation measures to ensure resilience against the locked-in climate impacts

DEMONSTRATE ACTION NOW

8. Set and deliver short-term targets, that drive action during this decade
9. Align the Board, management, and employees’ incentives to achieving net zero targets
10. Develop an action plan with specific operational implications and business model transformation to deliver net zero
11. Align capital expenditures and accounting practices to the delivery of net zero
12. Disclose transparently and consult climate transition plans with stakeholders

We believe that having a wider set of criteria than just a single quantitative future warming measure provides for a more robust, intuitive, and credible framework for measuring decarbonisation plans.

So what?

Whilst most insurers are looking to facilitate a longer-term transition, this does not come without challenges. We believe that insurers should look towards ESG as a whole (e.g. a Just Transition) rather than just focusing on the environmental aspect. Data continues to present challenges, particularly the methodology and how to disclose this in a coherent manner. Whilst the quantitative side is important, it is critical to also consider the qualitative assessments. Insurers should look to their asset managers for support in this important but complex area.

—

For Professional Clients only, not suitable for Retail Clients.

The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.

Issued in November 2022 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.

[1] Our intention is to decarbonise our in-scope directly managed funds in line with the real economy. We will also work closely with our segregated clients towards this goal where they have made explicit public commitments to net zero. Our efforts are focused on supporting the decarbonisation of the constituents of our funds through engagement (and not decarbonising our portfolio regardless of the real economy). The commitment is based on the expectation that governments and policy makers will deliver on commitments to achieve the 1.5°C temperature goal of the Paris Agreement. It also assumes this action does not contravene RLAM’s fiduciary duty to external investors. The commitment is baselined on the year 2020 and is being tracked using scope 1 and 2 carbon footprint using EVIC as an attribution factor (tCO2e/$m invested) for our corporate fixed income and equities portfolios.

HEADER 1

Andreew Epsom Solvency II Wire: Insurance Climate Disclosures- present state and future outlook

The author is Insurance Client Solutions Director at Royal London Asset Management. The views expressed are the author’s own.

Andrew Epsom participated in an expert panel discussion on insurance climate disclosures. Insurance Climate Disclosures – present state and future outlook, is a collaboration between Solvency II Wire, Royal London Asset Management and Slaughter and May, bringing together senior regulators and industry figures to discuss the challenges of ESG reporting in the insurance industry.

Insurance Climate Disclosures: present state and future outlook, was held at the offices of Slaughter and May in London, on 14 June 2022.

Articles in the series